Procurement

Defining the Incoterms and Their Impact on Total Landed Cost

Mar 21, 2014

[Editor's Note: This is the fourth article in a series covering topics related to total landed cost by contributing writer Marilyn Gettinger. See links to her first three articles at the end of this article.

cargo1The International Chamber of Commerce published the first set of International Commercial Terms, or Incoterms, in 1936. The objective was to standardize the business vocabulary used in buying and selling on a worldwide scale. The ICC has amended and modernized these rules several times: 1953, 1967, 1980, 1990, and 2000. Revised Incoterms were also published again in 2010 to reflect current international trade practices. The Incoterms clarify responsibilities in the shipment of goods internationally for documents, licenses, port fees, carriage, insurance, terminal costs, duties, delivery fees, etc

The purpose of the Incoterms is to:

  • Eliminate barriers caused by distance, language, and local business practices in global business dealings
  • Eliminate uncertainties and different interpretations of trade terms on a worldwide scale
  • Reduce the risks, delays, and disruptions caused by misunderstandings, disputes, and litigation
  • Provide a universal vocabulary accepted by all of the major international financial institutions
  • Minimize problems at critical points.

One of those critical points occur where the seller's responsibility ends and the buyer's responsibility for the shipment begins. This critical point includes the hand-off of costs, risks, and documents. A misunderstanding of responsibility at a critical point will delay a shipment, cause customs problems, and impact the letter of credit payment.

The Incoterms spell out which party has responsibility for:

  • Risk of loss
  • Delivery
  • Export/import licenses
  • Customs clearance
  • Contract of carriage
  • Contract of Insurance.

The Incoterms do not deal with:

  • Transfer of property rights in the goods (title)
  • Relief from obligations and exceptions from liability in cases of unexpected or unforeseeable events
  • Consequences of various breaches of contract except those relating to the passing of risks and costs when the buyer is in breach of its obligation to accept the goods or to nominate a carrier under the F group of Incoterms.

How the Incoterms Are Structured

The 2010 version of the Incoterms include 11 terms segmented into four main groups.

E- Departure

Ex-Works -- Goods made available for pickup.

Buying organization is responsible from pickup to delivery for all costs and risks of loss or damage.

F - Main Carriage Unpaid

FOB -- Free on Board (...named port of shipment)

The seller delivers the goods on board the ship and clears the goods for export.

From that point, the buyer bears all costs and risks of loss and damage.

FCA -- Free Carrier (...named place of delivery)

The seller delivers the goods, cleared for export, to the carrier selected by the buyer.

From that point, the buyer bears the costs and risks of moving the goods to destination.

The seller loads the goods if the carrier pickup is at the seller's

FAS -- Free Alongside Ship (...named port of shipment)

The seller delivers the goods to the origin port.

From that point, the buyer bears all costs and risks of loss or damage.

C - Main Carriage Paid

CFR -- Cost and Freight (...named port of destination)

The seller clears the goods for export and pays the costs of moving the goods to destination.

The buyer bears all other costs and risks of loss or damage.

CIF -- Cost, Insurance, and Freight (...named port of destination)

The seller clears the goods for export and pays the costs of moving the goods to the port of destination as well as the insurance.

The buyer covers all other costs and all risks of loss or damage.

CPT -- Carriage Paid To (...named place of destination)

The seller pays for moving the goods to the destination.

From the time the goods are transferred to the first carrier, the buyer incurs costs and risks of loss or damage.

CIP -- Carriage and Insurance To (...named place to destination)

The seller pays for moving the goods to the destination as well as the insurance.

From the time the goods are transferred to the first carrier, the buyer incurs costs and risks of loss or damage.

D - Delivered

DAT -- Delivered at Terminal (...named terminal at port or place of destination)

The seller delivers when the goods are placed at the buyer's disposal on the arriving means of transport ready for unloading at the named port or place of destination.

"Terminal" includes any place, including a quay, warehouse, container yard, or road, rail, or air cargo terminal.

The seller bears costs and all risks involved in bringing the goods to and unloading them at terminal at the named port or place of destination.

DAP -- Delivered at Place (...named place of destination)

The seller delivers when the goods are placed at the buyer's disposal on the arriving means of transport ready for unloading at the named place of destination.

The seller bears all costs and risks of moving the goods to the named place.

DDP -- Delivery Duty Paid (...named place)

The seller delivers the goods, cleared for import, to the buyer at destination.

The seller bears all costs and risks of moving the goods to destination, including the payment of customs duties and taxes.

The Incoterms need to be followed by a so-called "named point," such as a port or place. The terms are specific per mode of transportation.

Picking the Right Incoterm

Many organizations with little experience in international logistics tend to rely on their international suppliers to manage the process. As they become more familiar with international shipping, the organizations may move from DDP, or Delivered Duty Paid, to the next Incoterm, DAT, or Delivered At Terminal, and then move on up and through the Incoterms, taking on more responsibility for the shipments.

This progression offers the buying organization the opportunity of negotiating the various rates included in the Incoterms.

In selecting an Incoterm, the buying organization may also consider:

  • The amount of control it wants
  • The buyer-seller relationship
  • Origin and destination country's customs
  • Accounting department's ability to handle foreign exchange transactions
  • Physical presence in the country of origin
  • Contract of carriage rates.

The buying organization should take precautions:

  • Attach a formal explanation of the Incoterm selected to the contract or purchase order
  • Request a confirmation of acceptance of all responsibilities of that Incoterm from the supplier/customer
  • Draw up a checklist of all duties and rights under the selected term and ensure that all transactions are met and nothing is omitted
  • Request that the supplier/customer also create a checklist
  • Exchange checklists
  • Request that the supplier/customer change or add nothing or as little as possible to the selected term
  • Require signed acceptance in the event that a change or addition is required.

Impact on Total Landed Cost Calculation

When the Ex-Works Incoterm is selected, the importer of record incurs all of the logistics costs from the supplier's dock to its own delivery point. All of these costs are then added to the unit price and become the total landed cost.

If the Delivered Duty Paid Incoterm is selected, the supplier incurs all of the logistics costs from its own dock to the buying organization's delivery location. The buying organization should be billed at the unit price times the number of units shipped. However, it is important to identify if the various logistics costs have, in fact, been added into the unit price.

At the critical point of a selected Incoterm, the seller's costs end and the buying organization's costs begin. These costs need to be added onto the unit price to identify total landed costs.

It is critical for an organization to accurately capture its costs from the critical point through to delivery to ensure an all-inclusive selling price. A more in-depth explanation of each of the Incoterms can be found in the International Chamber of Commerce publication Incoterms 2010.

Marilyn Gettinger is owner and principal of New Directions Consulting Group, which works with organizations on improving their supply chains through process streamlining and reengineering. New Directions Consulting Group offers workshops and consulting to companies from 30 employees to multinational corporations to upgrade purchasing, inventory, and supply chain processes. Gettinger, who earned her MBA from Fairleigh Dickinson University, teaches total quality management, supply chain management, and international trade at several post-secondary schools. She holds a C.P.M. and is a member of the Institute for Supply Management and the American Production and Inventory Control Society.